Sunday, 3 August 2008

The Credit Crisis Turns One

By Prashant Gopal

Happy birthday, credit crisis. It was a year ago August that the world began to suspect the economy was heading into something worse than a slump. Now as another August heaves into view, the credit crisis is a year bigger and -- like many 1-year-olds -- indiscriminate about where it makes its messes. The real concern is how much bigger it will get.

The crisis has transformed the housing market from weak to downright disastrous. Home prices are tumbling, foreclosures are spiking, and the bottom of the market seems more distant than ever. Gone are the loose lending standards that helped millions of people buy houses they couldn't afford otherwise. Today, securing a loan can be tough, even for buyers with decent credit.

The world was not braced for the impact the real estate slump would have on the financial industry. It was on Aug. 1, 2007, that two Bear Stearns hedge funds heavily invested in mortgage-backed bonds filed for bankruptcy, and another had its assets frozen following mortgage-related losses. Within a week, Luxembourg's Sal. Oppenheim, one of Europe's largest private banks, announced it had temporarily closed a 750 million asset-backed securities fund it managed for Austrian investment foundation Hypo KAG. And, on Aug. 9, BNP Paribas (BNPP.PA), France's biggest bank, followed suit by freezing $2.2 billion worth of funds exposed to the subprime mortgage market. On that same day Dutch merchant bank NIBC canceled a flotation plan after revealing a $188.6 million loss from U.S. asset-backed securities. It was becoming apparent that many of the mortgage-backed securities that had been used to pump billions of dollars into the global economy were considerably overvalued. Lenders around the world were getting very nervous, very fast. They had reason to be.

Losses from the Crisis

Since last August losses suffered by all financial institutions on assets originated through 2007 are expected to total some $925 billion, equal to about 3% of all assets, according to Moody's Economy.com. The largest losses, expected to total $525 billion, will be on residential mortgage loans. Once mighty companies such as Bear, Countrywide Financial, and IndyMac have gone under or been acquired, and dozens more, such as Fannie Mae (NYSE:FNM - News), Washington Mutual (NYSE:WM - News), Citigroup (NYSE:C - News), and Wachovia (NYSE:WB - News) are hanging on by a thread. And it's not just the housing and financial sectors that have been battered. The credit crisis has spread to infect the automotive, airline, travel, and retailing industries.

The outlook seemed much rosier last summer. Treasury Secretary Henry Paulson in June 2007 declared that "we are at or near the bottom" of the housing slump. At that time, median single-family home prices had fallen just 1.5% in the second quarter of 2007 from the previous year, according to the National Association of Realtors. And Paulson said he believed that housing losses had been "largely contained" and would not significantly damage the overall economy.

Since then the housing slump has spread across the country, helped along by more restrictive lending standards. But the worst problems are still concentrated in states such as Arizona, California, Florida, and Nevada, where new construction, speculation, and risky lending practices were rampant. And the wealthy areas seem to be riding out the downturn better than the poor and middle-class areas, where subprime lending was more common.

Tale of Two Zip Codes

BusinessWeek.com asked Mountain View (Calif.)-based Altos Research to look at what has happened to listing prices for homes in 20 large U.S. metropolitan areas since the mortgage crisis began last summer. We selected the best and worst performing ZIP codes in each metro area and discovered that, in almost every case, the listing prices in the strongest performing areas had weathered the year much better than those in the weakest performing ZIP codes.

Many affluent markets are benefiting from the weak dollar, which has attracted bargain hunters from Europe and Canada. Those buyers can also pay cash, so finding a mortgage isn't much of an issue. "The well-financed people are able to go in and buy what they want to buy and they're buying closer in, whereas two years ago they were just settling because there was more competition," said Michael Simonsen, co-founder and CEO of Altos Research.

Consider Davie, Fla., in suburban Fort Lauderdale, where the average asking price dropped 30% to $276,661 in the year ended in July. Drive about an hour north in Palm Beach County and you'll reach Jupiter, a wealthy beach town that is one of the few bright spots in the South Florida real estate market. Median listing prices in Jupiter actually rose 24% from July 2007 to July 2008. The median rose, in part, because the mix of listings now includes a larger share of homes selling for $1.5 million or more.

Kris Heiser, vice-president of Mako Appraisal in Jupiter, said homes on the market for more than $3 million are selling well because buyers in this range aren't affected by the tight credit market and can afford the state's high property taxes. On the other hand, homes selling for $700,000 to $1 million are taking a hit. "We've seen very steady sales, very steady prices," Heiser said. "Jupiter is one of the places that have not been devastated."

"Really Ugly" Market

In Richmond, Calif., an inner suburb of San Francisco where the largest employer is a Chevron (NYSE:CVX - News) refinery, asking prices fell 49% to $202,771 in the last year. But less than 20 miles away in Tiburon, one of the wealthiest ZIPs in the nation, asking prices jumped 20% to $2.965 million. Deena Love, a partner at David Levine Appraisal Group, said Richmond was popular during the boom among investors and borrowers with less-than-stellar credit because it was relatively affordable in a region where real estate is spectacularly expensive. The market now is "really ugly," she said. "There's a glut on the market with all the foreclosures."

Michael Bordo, professor of economics at Rutgers University, believes the housing market likely won't recover for another two years. But the housing bill signed by President George W. Bush on July 30 could help. The aid package is designed to shore up Fannie Mae and Freddie Mac (NYSE:FRE - News) and allow as many as 400,000 homeowners to avoid foreclosure by refinancing into smaller, fixed-rate, government-backed loans. Bordo said the housing plan will probably help put a floor on the market. But the problems facing lenders will continue, and many regional banks are likely to fail in coming months, he said. One hopes that by its second birthday in August 2009, the housing crisis won't be in its terrible twos.

No comments:

Goldman Sachs Information, Comments, Opinions and Facts

About Me

A simple girl interested in sharing financial tips and news from the United States and Singapore. Many people focus on how to get rich. But some forget that their eventual objective is to be happy. And some also forget that the best way to be free from poverty and maintain wealth after getting rich is to be free from scams.